Research insights from active investors

On the ground in China

Daniel J. Graña, Portfolio Manager, June 25, 2010

Walking through a gauntlet of vendors hawking their produce through headsets and microphones only to be confronted by a continuous stream of commercials projected on large television screens at the end of shopping aisles, the first-time visitor may find the shopping experience at Chinese retailer Wumart* a culture shock.

But for native Chinese, the experience resonates with traditional ways of shopping for produce and home goods.

And for the investor, it’s an opportunity to see firsthand how a leading retailer is implementing a strategy to capture some of the nation’s fast-growing consumer market.

To appreciate the impact of urbanization and growth in China, you have to see it from the ground.

As a frequent traveler to emerging-market countries, including frequent research trips to China, I am always in awe of the changes I see.

A changing horizon

From one trip to the next, I see so many new buildings that have gone up. In Shanghai alone, the new construction is equivalent to building the entire skyline of the city of Boston — every year.

That’s why each trip I make to China includes on-the-ground visits to individual companies, government officials, and sector specialists.

The best way to gain insight is with site visits.

Although my plans are always ambitious, I should know better than to try to make six company visits in one day. With China’s urbanization has come some of the world’s worst traffic and depending on the intensity, I am lucky if I complete four or five meetings in one day.

The government’s goal is to have 75% of the country urbanized within the next two decades. That is the equivalent of the entire population of the United States — 380 million people — moving to the cities.

As a result, in every industry sector, it’s full steam ahead.

The indoor wet market

Wumart is a good example of one retailer’s strategy to expand in a growing market. In my most recent trip to Beijing, I met with an executive of the company at one of the stores to learn about its growth strategy.

China has a history of “wet markets,” which are similar to our open-air farmers’ markets, where lines of tables and stalls feature fresh produce, seafood, and meats for sale. In fact, these markets continue to be a popular place for the Chinese to buy their produce. In Beijing alone, it is estimated that 40% of the produce purchased is through wet markets.

In order to capture a larger share of this business, Wumart has embarked on a strategy to replicate that experience indoors, complete with hawkers calling loudly to shoppers: “Come over here, my food is cheaper and fresher than theirs!”

The store also features large television screens at the end of each aisle, airing rotating commercials for various products.

The strategy seems to be working. The mass market seems to be more comfortable at Wumart than at the stores of its foreign competitors.

And for retailers, creative strategies are needed to differentiate themselves as they try to keep up with the growing competition in the cities.

Growth has consequences

While that level of growth may seem exciting from an economic standpoint — creating more jobs and wealth for the population — the accelerated growth environment has also had a negative impact.

Much of what was built under the previous government leadership was done without regard for the environment.

On most days in Beijing, you can stare straight at the sun and not hurt your eyes because the pollution is so thick. It is estimated that about 85% of Chinese rivers are now fully polluted.

But the current government is making an effort to clean up the pollution. While high on the agenda, the cleanup is a major undertaking.

Still, the renewed focus on the environment has led to economic growth as well.

Flying west, you can visit one of the country’s newest wind farms, which represents a commitment to alternative energy. China now has the largest wind industry in the world after only three years. And their goal is to generate 15% of their country’s electricity from alternative energy sources by 2020.

They are building wind turbine blades and gear boxes, and beating their competitors.

And I have no reason to doubt that they will meet their goals.

* Wumart is not a current fund holding.

Consider these risks before investing:

International investing involves certain risks, such as currency fluctuations, economic instability, and political developments.

Additional risks may be associated with emerging-market securities, including illiquidity and volatility.

The fund may invest a portion of its assets in small and/or midsize companies. Such investments increase the risk of greater price fluctuations.

The use of derivatives involves special risks and may result in losses.

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